2 Commercial REITs Building on Solid Foundations

Commercial real estate has not attracted the same level of attention as single family homes but this segment of the market has also been improving over the last year.

Vacancies rates have been declining and occupancy rates are slowly rising once again. Loan default rates have been trending down as well. While the major markets such as Washington and New York are doing better than the secondary cities and suburban locations office properties, hotels and industrial real estate around the nation are slowly improving.

While REITs in general are overvalued right now, there are still some lesser-known REITs specializing in commercial properties that are still cheap enough to qualify as bargain issues worth considering by long-term, asset-based deep value investors.

Summit Hotels (INN[1]) owns 92 properties with more than 11,000 rooms in 24 states. The company focuses on premium-branded, select-service hotels in the upscale and upper midscale segments in markets with what they call multiple demand generators such as retail centers and corporate headquarters. The company has been actively buying properties lately, with four announced acquisitions in the last quarter. So far this year, INN has purchased 19 properties for more than $400 million. The company also just finished an equity offering to allow it to continue the buying spree.

The company is content to let the other hotel REITs focus on the so-called gateway markets, because Summit believes it have an opportunity in “beltway markets” with strong demand generators. INN has a strong relationship with Marriott (MAR[2]), Hyatt (H[3]) and Hilton (HLT[4]) that gives the company exposure to a wide range of acquisition opportunities, and Summit has taken advantage of it so far. Since the company’s IPO the number of location operated by INN has grown from 65 to the current 92 locations, with the total number of rooms has grown from 6533 to more than 11,000.

The stock is still cheap at the current price. Shares trade at a little less than 90%of book value. You get paid to wait for an improvement with a sizable 5.2% dividend yield. This is a collection of high-quality hotel properties at a discounted valuation that should provide solid returns for patient value-oriented investors.

Arbor Realty (ABR[5]) is in the finance side of the commercial real estate industry. The company provides commercial real estate-related bridge loans, junior participating interests in first mortgages, mezzanine loans, preferred and direct equity, discounted mortgage notes, and also invests in mortgage-related securities and real estate property. Right now, the loan and investment portfolio is about $1.8 billion with an average yield of 5.6%, and 70% of the loan portfolio is variable rate so this is one of the few REITs that will benefit from rising interest rates.

Shares are trading at 87% of tangible book value, although management says that adjusted book value is much higher when accounting for margins posted for swaps transactions. At today’s price the shares are yielding 7.8% so you are also getting paid to with for the value to be unlocked in this commercial real estate REIT.

Commercial real estate markets around the US should continue to slowly improve. While there are not as many bargains as in the past, there are still some securities that trade at a discount to asset value and have the potential for returns measured in multiples and not just double-digit percentages.